In an interview last week (see link below), SEC Chair Paul Atkins touted tokenization as the key to modernization of US financial markets. While “tokenizing $68T worth of securities in the next few years” might be an aggressive goal, the point made by Atkins is an important one – tokenization is likely going to be a big trend. Because of that, we’ve got numerous questions about the tokenization of traditional assets and how it affects the rest of crypto.
Defining Tokenization
“Tokenization” most broadly means representing ownership or rights to an asset, whether it be physical, financial, or even digital, as a token on a blockchain, making it easier to transfer, divide, verify, or automate. The most popular example of this we have today is stablecoins. Issuers, such as Circle or Tether, hold dollars on behalf of clients and issue them tokens on a blockchain. One can do the same with shares of a stock, ownership interest in a fund, or even a physical asset such as gold.
Form and Function Differ Greatly
It’s important to understand that even though “tokenized” traditional financial products are an exciting market development with nearly $400B of “represented value” (not including aforementioned stablecoins) according to data aggregator RWA.xyz, their form and function differ greatly, eliciting important philosophical questions about the purpose of blockchain technology.
On one end of the spectrum, we have open, decentralized, and permissionless blockchains. Think Bitcoin and Ethereum. Anyone can become a validator/miner, inspect the blockchain, download the software, and run a node. On the other end, we have closed or permissioned blockchains. Technically, transactions are grouped and chained together with cryptographic signatures, but entry to the network or even access to the data or software is gated by say a bank or financial/technical consortium. Not all blockchains are equal, which is why saying “it’s on a blockchain” or “it’s tokenized” evokes important questions of “where?” or “how?”
Tokenization Doesn’t Imply Open Access
The largest network for RWAs today is the Canton Network, created by Digital Asset, with $380B of repurchase agreements on the network, or 91% of the total “represented value” of all RWAs. It operates as a privacy-preserving network, but is permissioned, meaning it is not a public network. Not everyone can run a node, become a validator, or deploy dapps on the network. To meme quote Boromir from LoTR, “one does not simply become a Canton validator.”
For open or permissionless networks, Ethereum is by far and away the most popular chain with $12.1B of RWAs deployed on it. BNB Chain is the second largest with $1.8B worth of RWAs. Tokenized U.S. Treasury funds are by far the most popular application there, with $8.6B of the $12.1B of RWAs.
But even on an open, permissionless network such as Ethereum, the design of the specific tokenized asset can vary greatly. And because these RWAs are often securities, broker-dealers, KYC/investor accreditation, whitelisted wallets, transfer agents, and other structures from traditional finance are required. Boromir again here: “one does not simply buy an RWA on Coinbase (a centralized exchange) or Uniswap (a decentralized exchange).”
Why Tokenize on Closed Systems?
So, if RWAs still require permissioned networks or traditional financial structures around it, why build them? What’s the benefit? Right now, near instant settlement, 24/7 operations, programmatic ownership, transparency, auditability, and collateral efficiency. These are big benefits, even at the onset. In the future, if things become more open and regulations become more favorable, as Chairman Atkins suggests, access to these assets should become more democratized, and thus these RWAs would enjoy expanded reach, in addition to all the previously mentioned back and middle office benefits.
The Benefits To Crypto
The benefits to networks these assets reside on, such as Ethereum, are light at first, but increase as their access and interoperability and composability increase. Initially, the benefits for Ethereum are transaction fees generated by the usage of the RWAs (part of which are used to burn ETH supply). Ethereum, or the home blockchain, would also enjoy increasing network effects of being the place where RWAs and other assets are built. In the future, one could see these RWAs being part of DeFi (composability), either as collateral for borrowing, an asset to be lent out, or for trading.
This will take time as technology develops, infrastructure is built out, and rules and regulations evolve. “One does not simply become composable and interoperable RWA” to meme quote Boromir one last time. But the future is exciting, and investors should pay attention, even if the economic impacts to traditional cryptocurrencies are minimal today.
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